HE2001 Intermediate Microeconomics

Lecture 2: Utilitarianism

Pak Hung Au

Division of Economics, Nanyang Technological University, Singapore

Jan 2020

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Introduction

We saw last time that any way of aggregating individual preferences

into a social preference is problematic in some sense.
To proceed, we need to compromise in some way.
To avoid dictatorial outcome, we need to give up either one of
universal domain (UD);
Pareto; or
independence of irrelevant alternatives (IIA).

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Pareto Dominance

Giving up Pareto means that we ignore individuals’preferences even if

there is unanimity. We do not want to do that.
What if we just require Pareto?

De…nition
Alternative A Pareto dominates another alternative B if every individual
weakly prefers A to B and at least one individual strictly prefers A to B.

Pareto dominance is a way of ranking alternatives: if A Pareto

dominates B, and B Pareto dominates C , then A Pareto dominates C .
However, it is an incomplete ranking: often neither alternative Pareto
dominates the other. For example:
giving away a movie ticket;
dividing $100 among the class;
university admission.
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Pareto E¢ ciency

But when Pareto dominance gives us a ranking, it would be very

compelling.
We should never choose an alternative that is Pareto dominated.
That is, we should always choose only a Pareto e¢ cient alternative.

De…nition
An alternative is Pareto e¢ cient if there is no other alternative that Pareto
dominates it.

In other words, an alternative is Pareto e¢ cient if there is no

unanimously better alternative.
If there is only one Pareto e¢ cient alternative, then it is the obvious
choice.
However, often there are many Pareto e¢ cient alternatives. We need
extra criteria to determine which Pareto e¢ cient alternative to select.
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Social Choices with Money Transfer

Let’s allow for monetary transfer in our social choice problem.

How much money are you willing to pay for the movie ticket?
An individual’s truthful answer is his/her willingness to pay for the
ticket.
Willingness to pay adds more information about an individual’s
preference.
Before: we just talked about whether he likes A or B better;
Now: we can talk about how much more he likes A than B.

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Social Choices with Money Transfer

Recall that any allocation of the movie ticket is Pareto e¢ cient.

Suppose now we assign the ticket to Joseph whose willingness to pay
is lower than that of Ivy.
Consider the following new alternative:
we give the ticket to Ivy instead;
we take away $x from Ivy and transfer it to Joseph
$x is chosen to be higher than the Joseph’s willingness to pay, but it is
below Ivy’s willingness to pay.
This new alternative Pareto dominates the initial alternative of giving
the ticket to Joseph (with no monetary transfer).

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Social Choices with Money Transfer

When money is involved, the only Pareto e¢ cient alternative involves

one that give the ticket to the person with the highest willingness to
pay.
Take an alternative in which the ticket is given to someone that does
not have the highest willingness to pay.
One can construct a new alternative as above that Pareto dominates it.
If an alternative is Pareto dominated, then it is not Pareto e¢ cient.

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Social Choices with Money Transfer

Formally, a monetary transfer scheme can be represented by

t = (t1 , t2 , ..., tn ) where
ti denotes the amount of money received individual i. (could be
negative, a payment)
∑ni=1 ti = t1 + t2 + ... + tn is the budget de…cit. (could be positive, a
surplus)
∑ni=1 ti = 0 means that the transfer scheme has a balanced budget.
Now a social choice consists of two components:
an alternative (e.g., who gets the ticket; who gets admitted);
a monetary transfer scheme t (who pays whom and by how much)
A combination of an alternative and a monetary transfer scheme is
called an allocation.

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Quasi-linear Utility
The notion of willingness to pay can be captured by quasi-linear
utility functions.

De…nition
The value to individual i from alternative x is denoted vi (x ). The utility
associated with alternative x together with monetary transfer ti is

Ui (x, ti ) = vi (x ) + ti .

Individual i prefers a pair (x, ti ) to a pair (y , ti0 ) if and only if

Ui (x, ti ) Ui (y , ti0 ). If the inequality is strict, then we say his preference
is strict.

If all individuals have quasi-linear utility functions, then utility can be

compared and transferred across individuals.
From now on, preferences (individuals and social) are de…ned over
allocations.
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Quasi-linear Utility and Willingness to Pay

How does a quasi-linear utility function capture willingness to pay?

Recall the ticket example. We write xi to stand for allocating the
ticket to individual i, and write x i to stand for allocating the ticket
to someone other than individual i.
Suppose individual i has no value from not getting the ticket, so
vi (x i ) = 0.
In deciding between (xi , ti ) and (x i , 0), individual i prefers the
former if and only if

Ui (xi , ti ) Ui (x i , 0) , vi (xi ) ti vi (x i )
, ti vi (xi ).

This means individual i is willing to pay up to, but no more than,

vi (xi ) to get the ticket.

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Quasi-linear Utility and Willingness to Pay

More generally, if A and B are any two alternatives, and ti is a

number, individual i prefers (A, ti ) to (B, 0) whenever

Ui (A, ti ) Ui (B, 0)

which translates to
ti vi ( A ) vi (B ).
vi (A) vi (B ) therefore measures individual i’s willingness to pay to
have A rather than B. (this may be negative.)

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Utilitarian Social Welfare Function

De…nition
A utilitarian social welfare function aggregates individual preferences by
summing up individuals’utilities. Speci…cally, the society ranks allocation
(A, t ) above another allocation (B, t 0 ), i.e., (A, t ) (B, t 0 ) if and only if
n n
∑ Ui (A, ti ) ∑ Ui (B, ti0 ).
i =1 i =1

In particular, if t and t 0 have a balanced budget, then this reduces to

n n
∑ vi (A) ∑ vi (B ) .
i =1 i =1

An alternative is utilitarian if it maximizes ∑ni=1 vi (A).

The utilitarian SWF satis…es IIA and Pareto and is not a dictatorship.
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Pareto E¢ ciency

Allocation (A, t ) Pareto dominates another allocation (B, t 0 ) if every

individual weakly prefers (A, t ) to (B, t 0 ) and at least one individual
strictly prefers it. That is, Ui (A, ti ) Ui (B, ti0 ) for all individual i
and Ui (A, ti ) > Ui (B, ti0 ) for at least one individual i.
An allocation is Pareto e¢ cient if there is no other allocation that
Pareto dominates it.
In the subsequent analysis, we restrict attention to monetary transfer
schemes that have a balanced budget.
Otherwise, the question of Pareto e¢ cient allocation is meaningless as
one can always give more subsidy to each individual to get a Pareto
domination.

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Utilitarianism and Pareto E¢ ciency

Theorem
Suppose all individuals have quasi-linear utility function and only
budget-balanced monetary transfers are possible. An allocation (A, t ) is
Pareto e¢ cient if and only if A is an utilitarian alternative.

We …rst show that if A is utilitarian, then (A, t ) is Pareto e¢ cient.

Take any other alternative, say B. Then we must have
∑ni=1 vi (A) ∑ni=1 vi (B ).
Can we come up with some monetary transfer scheme t 0 such that
(B, t 0 ) Pareto dominates (A, t )?

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Utilitarianism and Pareto E¢ ciency

For (B, t 0 ) to Pareto dominate (A, t ), it is necessary that for all

individual i,
vi (B ) + ti0 vi (A) + ti ;
and at least one individual has a strict inequality.
Now sum over all individual i:
n n
∑ vi (B ) + ti0 > ∑ (vi (A) + ti )
i =1 i =1
n n n n
, ∑ vi (B ) + ∑ ti0 > ∑ vi (A) + ∑ ti
i =1 i =1 i =1 i =1
n n
, ∑ vi (B ) > ∑ vi (A) .
i =1 i =1

But this is not possible because A is utilitarian.

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Utilitarianism and Pareto E¢ ciency

Next, we show that if allocation (A, t ) is Pareto e¢ cient, then A is

utilitarian.
Again, take any other alternative, say B, and we ask, "Can B bring a
larger total value?"
Let’s couple B with the following monetary transfer scheme: we set
t̂i = (vi (A) + ti ) vi (B ) for each i.
All individuals are indi¤erent between allocations (B, t̂ ) and (A, t ).

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Utilitarianism and Pareto E¢ ciency

This implies that monetary transfer scheme t̂ cannot run a budget

surplus, for otherwise, (A, t ) would not be Pareto e¢ cient. Therefore,
n n
∑ t̂i 0 , ∑ [(vi (A) + ti ) vi (B )] 0
i =1 i =1
n n n
, ∑ vi (A) ∑ vi (B ) + ∑ ti 0
i =1 i =1 i =1
n n
, ∑ vi (B ) ∑ vi (A) .
i =1 i =1

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Summary

A satisfactory social welfare function allows us to evaluate and

propose institution and policies.
Arrow’s Impossibility Theorem tells us that there is no way to come
up with a consistent SWF that works universally.
We proceed by restricting our quest for a satisfactory SWF by
restricting ourselves to environments in which all individuals have
quasi-linear utility functions and monetary transfer is possible.
In such environments, Pareto e¢ ciency coincides with utilitarianism.
If we insist on choosing a Pareto e¢ cient allocation, then we must
adopt the utilitarian alternative (that maximizes the society’s total
values).

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